Trump Effect Or Long-Term Trend

10 May 2018

Asia Pacific

Americas

Political and Economic Risk Consulting

Andrew Gilholm

Trump Effect Or Long-Term Trend: A More Politicized Trade And Investment Climate Is Here To Stay

Last week’s US-China trade talks did little to allay fears that this summer will bring a scenario finally worthy of the name “trade war”. Beyond a few basic points of agreement and a vague commitment to hold further talks, there seems little real movement on key issues including the bilateral trade deficit and China’s industrial policies. Tense atmospherics, the absence of a meeting with President Xi Jinping or Vice President Wang Qishan, and the mutually unacceptable demands the two sides presented to each other all bode poorly for compromise.

Of course, these tough opening positions do not represent either side’s real bottom lines, and it remains highly uncertain how threats will translate into action. Most of the threatened US measures against China leave the administration great discretion over implementation, even after May-June deadlines for various consultations and recommendations on tariffs and investment restrictions. Many observers, including in China, are still betting that President Donald Trump will cut a deal far short of what his administration is currently demanding, and that some brinkmanship is just standard negotiating procedure, not a reflection of ideological commitment. There are three rough scenarios going forward:

Deal-art and de-escalation: There is certainly no lasting or comprehensive resolution of differences, but some formula sees Trump sufficiently satisfied with China’s (quite limited) offers and sufficiently concerned about the costs of escalation to drop, moderate or postpone many threatened actions. This would temporarily contain the situation as Trump proclaims a win for his tough tactics.

Escalation stations: After talks fail, the US implements most of its threatened tariffs and very significant investment restrictions; retains the ZTE Corporation ban and pursues an investigation into Huawei. China de-emphasizes its efforts to avoid escalation and be seen as rule-abiding, and retaliates with a wide range of measures including regulatory actions targeting US companies in China.

Stuck in limbo: Most threatened actions are neither executed nor shelved, as implementation decisions are held back or taken incrementally in a very lengthy process of mutual pressure for concessions. There is great protracted uncertainty for multinationals and further swings in market sentiment as the saga drags on to 2019 (even in the first scenario, there is a persistent risk of re-escalation).

The main determinant of how this plays out – and the key source of uncertainty – is whether Trump acts as the blustering deal-maker Beijing expects, or is bent on brinkmanship to force more fundamental change. China has so far remained reactive and restrained (focusing on “deeds not words”, it often says) in hopes that it can deter or dilute implementation. China sees the ball in Washington’s court and is in no hurry to make a deal, anticipating more pressure on Trump from consumers, business and interest groups, and indirectly from a looming, crucial juncture in Korean peninsula diplomacy.

China is probably right about this pressure, which is one reason why the compromise scenario is a very credible one, but Beijing is also planning for escalation; many businesses are wisely doing the same. Since Trump himself may not yet be decided on a course, and amid high stakes and complex dynamics, forecasting is inherently speculative. Companies’ ability to mitigate this uncertainty through lobbying is very limited. Planning for escalation does not just apply to tariffs and supply chain disruption, but also to potential impacts ranging from multiple forms of regulatory retaliation against US firms in China, to more politicized scrutiny by both governments of mergers and acquisitions and other investment activity.

Such planning is not only prudent pessimism for this summer, it is important even in the compromise scenario. This is because this year’s deterioration in bilateral ties – and particularly the shifts in April – have accelerated negative popular and political narratives in both countries that will probably not be reversed. Even if some accommodation is reached to contain the current situation, underlying causes of friction are not just about Trump but about structural factors that are very likely to persist for years to come. Periodic trade disruption, and an increase in restrictions on and scrutiny of multinational companies by both governments are thus likely to be long-term trends and go far beyond tariffs.

Tech-tonic shift

Trump’s first year in office was actually one of calm on US-China trade, relative to some expectations after this election. When alarm bells first started ringing in March, the escalation was quantitative and all about tariffs: steel and aluminium tariffs were followed by plans for wider duties targeting around USD 50bn worth of Chinese imports, and the threat of another list of tariffs targeting an additional USD 100bn worth of Chinese imports. However, it was April’s more qualitative escalation that makes a compromise look more challenging.

While trade deficit targets and specific market access concessions remain key demands, the debate has shifted increasingly to more systemic concerns about some of China’s highest-priority policies and practices: aggressive support for its domestic industries, particularly in advanced technology, including through the “Made in China 2025” strategy, which many countries consider unfair. These issues were a focus of the previous administration but their return to centre stage is more troubling to Beijing than tariffs, given the additional tactics Washington is now considering, and shifting dynamics:

The US Trade Representative investigation that prompted the latest tariffs also called for restrictions on Chinese investment in the US, with proposals expected in the coming weeks. It is not clear what form these will take, or if and when they might be introduced, but they will be designed to target sectors covered by the Made in China policy. They will also reflect restrictions on US companies in China, in line with the administration’s focus on the principle of reciprocity. Other steps may include restrictions on US firms’ activities in China – which could be an important long-term trend – and on Chinese nationals studying or researching in “sensitive” fields relating to advanced technologies at US institutions.

A side effect of this year’s intensified confrontation and evolving domestic debates has been growing political momentum in Washington for legislative as well as executive action. In addition to longstanding plans for Committee on Foreign Investment in the US (CFIUS) reform, the Fair Trade With China Enforcement Act is about to be introduced and, if it became law, would require by legislation many measures similar to those being considered through executive discretion, and more, including: banning the sale of “sensitive” technology or intellectual property; capping Chinese shareholdings in US firms; banning federal purchases of telecoms products from Huawei and ZTE; duties on Chinese capital goods in “sensitive” sectors; and raising taxes on the foreign income of multinationals which enter into “vulnerable” joint ventures with Chinese firms.

Most provocative for China were April moves against telecoms equipment giants Huawei and ZTE: the Department of Commerce on 16 April banned US firms from selling products to ZTE, and media reports claim the Department of Justice may be investigating Huawei (both cases involve sanctions against Iran and North Korea but no official allegations or charges have been made against Huawei). The moves raise the threat of very severe damage and disruption to China’s top two telecoms equipment companies, which also account for about one-third of the global market. ZTE’s production could be affected within weeks and Huawei in April scrapped a EUR 500m bond issue.

Ich bin ein ZTEer

In its view, China has a right to “catch up” economically like other industrializing nations before it, and it must develop advanced technology and industries – both to avoid the “middle-income trap” of getting stuck as a low-end manufacturer and to avoid reliance on foreign technology. The ZTE case increased the popular awareness and nationalist tenor of these arguments, and amplified Xi’s longstanding exhortations to develop domestic capacity in key technologies. From official media editorials to popular blog posts, there is also a stronger narrative along the following lines: the US is a hegemon and is determined to remain one; that means thwarting China’s rise, including by constraining its economic and technological development. In this view, trade complaints are a pretext for hobbling companies like ZTE and Huawei that could become global industry and future technology leaders.

Tougher US tactics have certainly made Chinese leaders take the threat of escalation more seriously, but for now have reinforced rather than weakened Beijing’s commitment to plans such as Made in China 2025. It immediately doubled down on plans to raise additional financing for related projects, and is increasingly confident that most Chinese will blame the fallout on a trade fight on US rather than Chinese leaders. The stronger patriotic tone of debate in China was summed up in a social media post by the editor of a major tabloid, which ended with (to paraphrase in translation) “we are all ZTE people”.

Meanwhile, there is growing bipartisan consensus in the US that after years of failing to change China’s behavior through diplomacy and engagement, the time has come for a tougher approach. Even many who oppose tariffs support other forms of stronger pressure, and view things increasingly through the lens of strategic national competition. The perception, fueled partly by Xi’s more overt ambition and unabashed brand of authoritarianism, is that Beijing is now simply too strong a competitor to be treated like a developing country and allowed to exploit US commitment to free trade and investment. As Senator Marco Rubio put it in a May 2 op-ed supporting the Fair Trade With China Enforcement Act: “The Chinese government and Communist Party are playing the long game, and we should, too.”

Chinese officials are not just posturing when they say they are ready to live with a trade war rather than be “bullied”, and are confident they can take the pain longer than Washington. But they may not grasp the similarly determined mood that might impact US decision making – the sense that this is about a long-term strategic threat, not just trade numbers, and that the short-term pain of trade confrontation is a necessary cost of challenging China’s behavior. It is hard to predict which scenario this summer will bring. However, longer-term trends point to a bilateral trade and investment environment that gets more, not less complex over the next several years.